Tellabs Warns Badly; Stock A Buy On Bounce?

Several firms are commenting on Tellabs (NASDAQ:TLAB) after the co issued a warning for Q4. The opinions are somewhat mixed:

- Morgan Keegan is downgrading the stock to Mkt Perform from Outperform saying they think many investors anticipated weak results for Tellabs for Q4:06, and they had reduced their estimates below consensus (December 11), but they didn't imagine results could miss by so much.

Firm acknowledges management's assertion that elements of the weakness are temporary and likely tied to the recently closed merger of AT&T and BellSouth; however, they suspect sales and earnings will not recover quickly for 3 reasons.

1) Weak sales stem from carriers' drive to control spending and not just the mergers, and this won't change soon.
2) Wireless capex likely declines materially in 2007, and this market had been a positive driver for the past 2 years.
3) Two out of the three growth areas for Tellabs have poor margin, Fiber to the Premises and optical transport.

Considering the degree of the shortfall, the firm doubts Tellabs management will sit back waiting for sales to recover. We anticipate management could adjust its cost structure to keep operating expenses below 30% of sales and bring operating margin back to the mid-teens. Furthermore, they imagine Tellabs could make an acquisition to improve its geographic mix, which could be a risk depending on the details. Finally, they think investors have downside protection considering the possibility that Tellabs becomes an acquisition target considering its enviable relationships and incumbent position with U.S. carriers.

- Morgan Stanley notes the magnitude of Tellabs revenue miss for 4Q06 (14% below MS estimate), along with similar announcements from ADCT, ADTN, and RBAK, is indicative of the weak wireline spending environment. While the revenue shortfall is partly related to a spending pause ahead of the recently approved BLS/T merger, they expect the challenging wireline capex environment to extend into the first half of 2007, or until technological and business-model issues surrounding telco video deployments show signs of improvement. Accordingly, the firm thinks it's too early to get constructive on TLAB shares despite the reasonable valuation. Maintains Equal Weight.

- Goldman Sachs is the most optimistic of the bunch noting it is important to keep in mind that the weakness is likely temporary in nature and that the outlook for 2007 remains healthy as Tellabs is a play on carrier bandwidth growth. Firm believes this miss will clear the decks and set a new lower bar for the stock, which may set up a positive long term scenario. Goldman continues to believe that the Street's topline estimates for 2007 remain too low. The 4Q miss is primarily due to the negative impact from long awaited merger of AT&T and BellSouth. They believe that the 2007 revenue outlook is likely dependent on new product traction (7100, 8600, and 8800), unlike 2006 where revenue growth was largely driven by strength in transport products. GS is adjusting their 4Q06, FY07, and FY08 estimates to $461mn/$0.11, $2,231mn/$0.64, and $2,412/$0.71 (excluding ESO) to account for the 4Q miss in revenues.

The firm is maintaining their 12-month price target of $11, and expect shares to be range bound in the near-term until confidence builds around the revenue and gross margin outlook. Maintains Neutral.
Notablecalls: While the news is not unexpected the magnitude of the miss will surely put pressure on the common. While both Morgan Keegan and MSCO make solid points regarding wireline capex in H107 and C07 in general, GSCO's comments regarding carrier bandwidth growth strike the core. Bandwidth will continue to grow no matter what. More of a question of when not if.

Think the stock becomes buyable for a bounce around 1.2-1.5 pts lower. Would not touch this one if it opens down any less than 1 pt. The valuation continues to be reasonable with potential buyout lurking in the background.

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